“This process is likely to take quite a bit of time, it’s not going to be smooth, it’s probably going to be bumpy”, Federal Reserve Chair Jerome Powell said on Tuesday in a speech in Washington DC, referring to getting inflation back to the Fed’s 2% target. But he could just as easily have been talking about the road to an eventual end of this bear market and a transition to a more sustainably bullish environment for stocks.
The conventional wisdom is that the current bottom recorded last October is probably “in” and, going forward, dips are going to be bought by short term investors and the larger the dip, the more aggressive the buying should be. Much as I would love for this to be the case, I do want to urge a degree of caution.
First, Powell, who has pushed back against the market narrative of peaking and then declining interest rates in 2023, has a long history of sounding one way in a speech - only to correct it at a later time. In fact, this has been a hallmark of Powell’s chairmanship. He will blow in the wind depending on the data that comes out in the coming days and weeks. Exhibit A will be the latest inflation data out this week (see THIS WEEK’S UPCOMING CALENDAR below).
Second, it’s not going to really matter to investors if we’ve reached peak hawkishness and peak interest rates if we’re heading for an economic hard landing (inflation conquered, but at the cost of a damaging recession), because stocks absolutely will drop from current levels in that instance.
While they might not take out that October low, we could easily be facing a 10%+ pullback on a hard landing, regardless of what the Fed does or doesn’t do. So, it’s essential that the evidence continues to point towards a soft landing, (inflation conquered, avoiding a damaging recession) so the data remains very important regardless of what Powell or his minions may say (see below).
Third, inflation absolutely must keep consistently falling from one print to the next, otherwise we risk a 1970’s style stop/start Fed rate hike campaign - and that uncertainty and apparent lack of control and competency on the part of the Fed would be the absolute worst-case scenario for both stocks and bonds.
Inflation is falling but it’s nowhere close to the Fed’s target yet. The labor market is making zero progress towards a better balance between available jobs and unemployment. For the sustainable, long-term economic growth which feeds ongoing higher stock prices, an economy must have highly visible and indisputable 1) low inflation and 2) healthy labor markets.
On that subject, Goldman Sachs last week reduced its likelihood of a recession this year from a 35% probability to 25%. That's good news for stocks.
At the same time, Fed officials swarmed across the country, busily ratcheting up the rhetoric to try to create a narrative that we are absolutely not out of the woods yet.
Federal Reserve Bank of New York president John Williams said the guidance for peak interest rates of 5.1% this year is still reasonable and that rates may need to be kept there for “a few years”.
Federal Reserve Governor Christopher Waller noted the central bank’s interest rate hikes are starting to “pay off” but it will take “some time” for inflation to get back to the 2% target.
Federal Reserve Governor Lisa Cook said the central bank is not yet done with interest rate increases but she still believes a soft economic landing is “possible”.
Federal Reserve Bank of Minneapolis president Neel Kashkari said he anticipates that interest rates will go above 5% at some point this year and expects them to remain high for a while to cool inflation.
Federal Reserve Bank of Atlanta president Raphael Bostic went much further, even referring at one point to the possibility of a 6.0% terminal rate.
In what is beginning to feel like a coordinated campaign to win the hearts and minds of the investing community, similar sentiments were also expressed last week by European Central Bank (ECB) officials, as well as JPMorgan Chase CEO Jamie Dimon who told Reuters that it's too early to declare victory over inflation.
This PR onslaught did seem somewhat successful in reining in some of the more wide-eyed optimism that we had seen the previous week and stocks spent most of the week stumbling along rather like a drunken sailor, continually taking one step forward and then two steps back to end up lower for the week. The exception was in the energy sector as Russia announced a cut in oil production, spiking oil prices and boosting the value of energy stocks.
With shorter-term interest rates moving higher at a faster pace than longer-term ones, the yield curve inversion between two year rates and ten year rates is at its widest level since the celebration time of Kool and the Gang in 1981. In olden timey days, an inverted yield curve and especially one inverting more and more steeply over a long period of time (we’ve been inverted since July 2022), was a nailed-on indicator of a recession right around the corner.
The inevitability of this effect is being challenged, however, as many observers are suggesting that if everybody suddenly knows about an assumed correlation, then maybe its efficacy is over and that a recession is far from unavoidable just because the yield curve inversion points that way.
We need to remain aware that, for stocks to remain buoyant in the face of still-rising rates, we need to see 1) inflation as shown by the Consumer Price Index (CPI) not to make any kind of comeback, starting this coming Tuesday, and 2) important economic readings show stability and ongoing unquestionable improvement. If we get the opposite, we may well need to prep for more painful volatility.
OTHER NEWS ..
What a difference a year makes .. This time last year, crypto exchanges and related products coughed up enormous amounts of money for plenty of high-profile Super Bowl advertising, many with celebrity endorsements. Today Fox Sports says there will be a grand total of none.
Back then, traditional financial institutions as well as highly-endorsed entertainers, influencers and sports stars were getting into crypto. Crypto evangelists puffed their chests out and bellowed that the El Salvador experiment and Russia’s subsequent invasion of Ukraine would soon help push crypto into the mainstream.
But just a few months of interest-rate hikes and risk-off sentiment in financial markets burst the bubble. The entire crypto ecosystem is now about a third of the size it was then. The complete collapse of Terra/Luna, Genesis, FTX and many others - often as a result of fraud, theft, incompetence or some combination of all three - has done untold damage to the industry’s reputation that was already fragile. Regulators can smell blood and are finally moving in.
Payward Inc.’s Kraken platform on Thursday said it had agreed to pay over $30m in fines to the Securities and Exchange Commission (SEC) over its staking practice, which essentially allows holders of some crypto coins to earn a yield from them, after regulators came down on the practice.
Regulatory sanctions on Kraken may just be the tip of the iceberg. The SEC has a problem with staking. It simply looks like exactly what it is, a financial service involving unregistered securities and you can be sure that the SEC is going to do something about that. That’s a big issue for those players still trying to make a living in the now-smaller crypto universe and always thought they could do so within the freedom of an unregulated environment. Good luck with that, bros.
Crashing shipping costs .. One of the main drivers of the recent significant drop in wholesale inflation affecting manufacturers is rapidly falling shipping costs. These costs climbed to historic highs in the second half of 2021 due to supply-chain stress and remained elevated through the first half of last year. Now it looks like they're coming back down to pre-pandemic levels.
The Freightos Baltic Index (FBX) is a widely recognized benchmark for global freight rates and has fallen 80% since its peak in late 2021. The FBX works in cooperation with the Baltic Exchange to create an aggregate of real-time market rates from global freight carriers.
Prices for FBX's top six major global shipping routes are down as much as 55% from just 90 days ago. That's important, as shipping costs are a key driver of inflation. The International Monetary Fund (IMF) estimates that when freight prices double, annual retail inflation rates increase by 0.7%. We are currently seeing the exact opposite of that.
The decline in freight prices over the past year has fueled the recent dramatic drop in prices paid by manufacturers this year. It also points to even further declines in the future that will ultimately feed through to dampening the retail measure of inflation.
UNDER THE HOOD ..
Following the bursting of the internet and technology bubble, the S&P 500 reached its lowest bear market low in October 2002. However, a new bull market did not get underway in earnest until March 2003. Some are seeing parallels in the current environment.
It is quite possible that the October 2022 low in the major price indexes was indeed “the bottom,” but that is something that can only be confidently determined with more hindsight than is available today. For now, the technical evidence points to some sort of low likely having formed then and the probabilities for further near-term gains are improving.
Last week’s declines, in terms of both price and indicators, were actually quite orderly, at least so far, given the overbought conditions they came from.
The problem is that while buyers are buying in most areas of the market, they are not putting increasing amounts of money to work, as would be expected as a major new uptrend unfolds. Net up/down volume has been falling since November 2022 and this includes January 2023.
However, the downtrend line from January 2022 has now finally been broken but while the full array of positive evidence may be promising, the characteristics surrounding the formation of the potential bottom do still leave some questions. The strength of the evidence increases the probabilities that any decline will likely be contained. But there are no guarantees and monitoring the resilience or the deterioration in the indicators will be crucial.
Anglia Advisors clients are welcome to reach out to me to discuss market conditions further.
THIS WEEK’S UPCOMING CALENDAR ..
You might want to buckle up this week, as hugely important inflation reports and more fourth-quarter results will be coming at us all. About 60 S&P 500 companies are scheduled to report including Airbnb, Coca-Cola, Cisco, Biogen, Shopify, Kraft Heinz, Applied Materials, Hasbro, Paramount, Door Dash, Deere and Marriott International.
The key event on the calendar this week, however, will be Tuesday's Consumer Price Index (CPI) measure of retail inflation for January. The consensus expectation is that the CPI increased by 0.5% in the month and 6.2% year over year. The Core CPI, which excludes food and energy components, is seen rising 0.3% month-to-month and 5.4% from a year ago.
We will also see Retail Sales (see EXPLAINER: FINANCIAL TERM OF THE WEEK below) for January on Wednesday and the latest Producer Price Index (PPI) measure of wholesale inflation felt by manufacturers on Thursday.
US INVESTOR SENTIMENT LAST WEEK (outlook for the upcoming 6 months) ..
This indicator now shows a bullish majority for the first time since March 2022 and is now at its most bullish since September 2021.
↑Bullish: 37% (30% the previous week)
→Neutral: 38% (35% the previous week)
↓Bearish: 25% (35% the previous week)
Net Bull-Bear spread .. ↑Bullish by 12 (Bearish by 5 the previous week)
Source: American Association of Individual Investors (AAII).
For context: Long term averages: Bullish: 38% — Neutral: 32% — Bearish: 30% — Net Bull-Bear spread: Bullish by 8
The highest recorded percentage of AAII bearish sentiment was 70% and occurred on March 5th 2009, right near the end of the Great Financial Crisis. The lowest percentage of AAII bears was recorded at 6% on August 21st 1987, not long before the stock market crash of October 1987.
Weekly sentiment survey participants are usually polled on Tuesdays and/or Wednesdays.
FEDWATCH TOOL ..
Data courtesy of CME FedWatch Tool, calculated from Federal Funds futures prices:
What are the latest market expectations for what the Fed will announce re: interest rate changes (Fed Funds rate) on March 22nd after their next meeting?
0% probability of no change (one week earlier: 3%, one month earlier: 16%)
91% probability of a 0.25% increase (one week earlier: 97%, one month earlier: 65%)
9% probability of a 0.50% increase (one week earlier: 0%, one month earlier: 19%)
LAST WEEK BY THE NUMBERS ..
Last week’s market color courtesy of finviz.com:
- Last week’s best performing US sector: Energy (two biggest holdings: Exxon-Mobil, Chevron) - up 5.1% for the week
- Last week’s worst performing US sector: Communications Services (two biggest holdings: Alphabet/Google, Meta/Facebook) - down 5.6% for the week
- The NASDAQ-100 fell by more than the S&P 500
- US Markets fell by less than both Emerging Markets and Foreign Developed
- Small Caps were the week’s biggest losers with Large Cap losing the least
- Growth stocks performed a little worse than Value stocks
- The proprietary Lowry's measure for US Market Buying Power is currently at 170 and fell by 20 points last week and that of US Market Selling Pressure is now at 126 and rose by 15 points over the course of the week.
- SPY, the S&P 500 ETF, remains above both its 50-day and 90-day moving averages and its long term trend line. SPY ended the week 11.6% below its all-time high (01/03/2022).
- QQQ, the NASDAQ-100 ETF, remains above both its 50-day and 90-day moving averages and its long term trend line. QQQ ended the week 19.3% below its all-time high (11/19/2021).
The Lowry’s Percent of Stocks Above Their 30-Day Moving Average reading last week fell from 78% to 58%.This important 0-100% reading measures overall positive stock participation. Higher readings indicate increasing positive market momentum, lower readings indicate increasing downside momentum. Extreme readings below 20% and above 80% could potentially point to imminent short term trend reversals.
- VIX, the commonly-accepted measure of anticipated stock market risk and volatility (often referred to as the “fear index”), implied by S&P 500 index option trading, ended the week higher at 20.5. It remains below its 50-day and 90-day moving averages and still well below its long term trend line.
ARTICLE OF THE WEEK ..
What is the most damaging financial trait you can have as an investor?
EXPLAINER: FINANCIAL TERM OF THE WEEK ..
A weekly feature using information found on Investopedia to try to help explain Wall Street gobbledygook (may be edited at times for clarity) .
The term "retail sales" refers to an economic metric that tracks consumer demand for finished goods. This figure is a very important data set as it is a key monthly market-moving event. Retail sales are reported each month by the U.S. Census Bureau and indicate the direction of the economy. It acts as a key economic barometer and whether inflationary pressures exist. Retail sales are measured by durable and non-durable goods purchased over a defined period of time. Sales for the report are derived from 13 types of retailers from food service to retail stores.
Retail sales are a good indicator of the pulse of the economy and its projected path toward expansion or contraction. Retail sales figures are reported by all food service and retail stores and compiled by the U.S. Census Bureau. The measurement is typically based on data sampling and is used to model the patterns for the entire country.
As a leading macroeconomic indicator, healthy retail sales figures typically elicit positive movements in equity markets. Higher sales are good news for shareholders of retail companies because it means higher earnings. Bondholders, on the other hand, are quite ambivalent towards this metric. A booming economy is good for all, but lower retail sales figures and a contracting economy would translate to a decrease in inflation. This may cause investors to gravitate toward bonds, eventually leading to higher bond prices.
Retail sales capture in-store sales, as well as catalog and other out-of-store sales of both durable (last for more than three years) and non-durable goods (those with a three-year or shorter life span). These are broken down into a number of different categories including (but not limited to):
Clothing & clothing accessories stores
Pharmacies & drug stores
Food & beverage stores
Electronics and appliance stores
Furniture stores
Gasoline stations
New car dealers
As a broad economic indicator, the retail sales report is one of the timeliest reports because it provides data that is only a few weeks old. Individual retail companies often provide their own sales figures at the same time every month, and their stocks can experience volatility as investors process the data.
Major changes in price can affect retail sales figures. These fluctuations in prices are seen primarily in two retail sales categories: food retailers and gas stations. Large increases in food and energy prices can cause sales figures to drop in both categories, thus affecting the sales of a particular month.
An accurate measure of retail sales is incredibly vital for gauging the economic health of the U.S. This is due to the fact that consumer spending, or Personal Consumption Expenditure (PCE), accounts for two-thirds of gross domestic product (GDP). Retail sales are reported in the U.S. on a monthly basis.
The data for the report is collected by the U.S. Census Bureau in its Monthly Retail Trade Survey. The report, which is released in the middle of every month, shows the total number of sales in the measured time period, usually the prior month, and the percentage change from the last report. The report also includes the year-over-year change in sales to account for the seasonality of consumer-based retail.
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